accounting essay

Companies Are Incorporated And Operated On The Premises Of Agency Theory Accounting Essay

Published: 23, March 2015

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Companies are incorporated and operated on the premises of Agency Theory. The Agency Theory spells out that there should be a working relationship between the management of the company and the investors of the company in order to maximize the shareholders wealth.

The direction for the traditional research of corporate governance was set up by Berle and Means (1932), when they presented an agency theory to separate ownership from control. This theory to separate ownership from control led to the evolution of the agency theory.

The early contenders of the agency theory assert that the agency relationship is a contract under which one party (the principal) engages another party (the agent) to perform some service on their behalf. (Coase, 1937, Jenson and Meckling, 1976 and Fama and Jensan, 1983). The agency theory is important, yet different authors and researchers see it from controversial perspectives. The basis of the agency theory appears from the separation of management and finances Sleifer & Vish, (1996). Agency theory is widely used as a framework in many research of corporate governance. It is used in research situations where the benefit on one party (the principal) is dependent on the behaviour and actions of second party (the agent).

The concepts and principles of corporate governance are mainly based upon the agency theory. Good corporate governance requires an effective board to lead the company so that it creates wealth for the shareholders and also to meet other stakeholders' expectations.

For example, Barclays Board of Directors, guided by Group Chairman Marcus Agius, runs the business on behalf of shareholders. As a scheduled company on the London Stock Exchange, Barclays meets the terms with the UK Combined Code on Corporate Governance.

Barclays Executive Committee includes the most higher-ranking leaders in the business, headed up by Group Chief Executive John Varley. It has proclaimed the expansion of its Executive Committee and alters to its organization and senior management tasks, placing its businesses to bring powerfully in the developing financial services industry.

Shareholders are placed as one of the stakeholders that managers must consider throughout their decision making on how a corporation can and should be set and implement direction Jonker J, (2003) in Freeman (1984).

Although the agency theory is expected to create a smooth and good relationship between the principal and the agent, there are some problems which arise because of the impossibility of perfectly contracting for every action of an agent whose decision affects both his own welfare and the welfare of the principal, ( Brennan, 1995).

Agency theory is concentrating at everywhere agency connection, in which one party (the principal) designate work to another (the agent), who carry out that work.

The theory is related with solving two problems that can occur in agency relationships. The first is the agency difficulty that happens when (a) the longing or objective of the principal and agent clash and (b) it is hard or costly for the principal to confirm that the agent had acted suitably. The second is the difficulty of risk sharing that happens when the principal and agent have dissimilar approach in the direction of the risk.

The problem here is that the principal and the agent may prefer different actions because of the different risk preferences ( Elsenhadt, 1989).

Barclays Capital and/or its associates may, from time to time, have places in, and may, as principal or agent, purchase or retail the Securities. Barclays Capital shall not be legally responsible to any individual on any base for any dead or costs happening directly or indirectly out of the exercise of or dependence on any of the assessment or in sequence set out herein. (http://www.barx.com/legal/index.html )

From the agency theory perspective, the objective of corporate governance is to ensure that managers resort to value maximizing strategies (Shleifer and Vishny, 1997). There have also been attempts to linkthe "resource based view" and the "managerial rents theory" (Castanians and Helfat, 2001) with corporate governance, in the strategic management literature. This view maintains that corporate governance variables are the factors, which are considered key and important to the effectiveness of Corporate Governance. Corporate Governance's key variables are closely associated with the success or failure of companies and a key managerial resource or human capital and thus a potential source of competitive advantage to the firm. Many companies have failed in the United Kingdom and this has stimulated debate about Corporate Governance. The collapse of the Maxwell Publishing Group in the late 1980s stimulated the Cadbury Report in 1992. In the 1990s cases like the Poly Peck, BCCI and Marconi further necessitated a need for proper Corporate Governance.

In looking at all these incidences of Corporate Governance inefficiencies and ineffectiveness, it is noticeable that some cases are clearly a matter of business planning and poor decision-making by management. The strategic planning is the sole responsibility of the board. This therefore points it out that the board composition plays a major role in the success or failure of the business.

As is clear now, BP could have put in more honest to additional diminish or keep away from the hazard of spilling oil into the ocean. Even with Green Project Management, if BP's choice was not to spend more in a risk response scheme, then maybe they should have approximate the party costs necessary for a clean-up activity as they are at present commencing.

(http://sustainablecitiescollective.com/richmaltzman/ )

The collapse of many companies is as a result of fraud. Fraud could be in form of cover-up and dissimulation by management or in some cases it could be the combination of both. The WorldCom in the United States and Maxwell, BCCI and Poly Peck in the United Kingdom are classic and living examples. Another issue is the question of regulatory oversight, as highlighted in the case of Enron.

Then Combined Code was introduced in the UK to restore the investor's confidence following many collapses and company failures of those big corporations.

The Directors are accountable for internal control in HSBC and for reconsidering its efficiency. Events have been planned for preservation assets against illegal use or temperament; for upholding good accounting records; and for the consistency of monetary information used within the business or for journal. Such events are considered to manage rather than do away with the risk of breakdown to attain business objectives and can only offer sensible and not complete declaration aligned with significant misstatement, fault, losses or fraud. The actions also allow HSBC Holdings to clear its obligations under the Handbook of Rules and Guidance issued by the Financial Services Authority, HSBC's guide supervisory body. (http://www.hsbc.com)

2.2.2 The Original Combined Code-1998

The Combined Code is made up of three main reports. The original combined code incorporates the recommendations of the Cadbury, Greenbury and Hampel reports

Cadbury Report (Cadbury, Sir Adrian, 1992)

The Committee issued a range of recommendations for good corporate governance in a Code of Best Practice. The Cadbury report addressed four main areas namely, Board of Directors, Non-executive directors, Executive directors and Company Accounts.

The main recommendations of the Cadbury report are explained below: (ICSA 2003 pp 151 - 152).

Board of directors

The board should meet regularly, monitoring the performance of the executive management.

Control over the company should be exercised collectively by the board of directors as a whole, with a clearly accepted division of responsibility between the chief executive and the chairman to avoid domination of the board by a single individual or by a small group of executive directors. The Code argued that it was desirable to separate these roles, so that the same person did not carry out both. It did not state that the same person should never be both chairman and chief executive, but recommended that when this did happen, there should be a strong independent element on board to act as a counter-force, with a recognized senior member to lead them.

The board should have formal schedule of matters specifically reserved to it for decision to ensure direction and control is firmly in its hands and does not allow power transfer to an all-powerful chief executive or chairman.

Non-executive directors

There should be a sufficient number of non-executives, appropriately qualified for the views to carry weight.

Non-executive directors should be able to bring independent judgment and experience to the deliberations of the that the executive directors on their own would lack.

Non-executive directors should be selected through a formal process and they should be appointed for a fixed term. Reappointment at the end of that term should not be automatic.

Executive directors

The service contract of an executive director should not exceed three years without shareholders approval. The purpose of this requirement was to set a limit to the size of the pay-off for a director who is forced to leave the company, or example as a poor performance and shareholder pressure. The remuneration of the executive directors should be decided by a remuneration committee, consisting wholly or mainly of non-executives.

The accounts of the company

The board should establish an audit committee of at least three non-executive directors, with written terms of reference. The board of directors should present a balanced and understandable assessment of the company's financial position to the shareholders including a statement in the annual report about the company's ability to continue as a going concern. The directors should report to the shareholders on the entire system of the internal control in the company.

The board of Lloyds group believe that superior governance is innermost to attaining the Group's governing idea of maximising shareholder price in excess of time. That has been highest in directors' attention when putting on the values restricted in the combined code on corporate governance issued by the Financial Reporting Council. (http://www.guardian.co.uk/business/ )

A board containing executive and non-executive directors with broad knowledge guide the Lloyds group.Â The selection of directors is measured by the board and, monitoring the necessities in the articles of association, they must stand for vote by the shareholders at the first annual general meeting following their selection and must leave, and may get up for re-election by the shareholders, as a minimum every three years. (http://www.lloydsbankinggroup.com/ )

Greenbury Report (Greenbury, Sr Richard, 1995)

In 1995 a committee was set up to look into the remuneration package and service contracts of the directors. The concern was centered around the 'fat cat issue'. This referred to the directors who paid themselves huge salaries. There was another concern regarding the failure of remuneration packages to provide a suitable incentive for directors to perform better. The report recommended the following are other things: Directors' remuneration and service contracts; Disclosure and Approval and Remuneration Committee (ICSA 2003, pp 152 - 153).

Directors' remuneration and Service contracts

A remuneration committee consisting entirely of non-executive directors should decide the remuneration of the executive directors' .The maximum notice period in an executive director's service contract should normally be twelve months, compared to the three years maximum recommended by the Cadbury code. In exceptional circumstances notice periods of up to two years might be reasonable ,by only occasionally should a notice period exceed this.

The Report included general recommendation about remuneration, but most of these were loosely phrased and open to broad interpretation. They included however:

Executive pay should not be excessive, but the remuneration committee should offer remuneration packages that are sufficient to attract, retain and motivate individual of the required quality.

The performance related elements of the remuneration should create a link between the interests of the director with those of the shareholders. The performance criteria should be 'relevant, stretching and designed to enhance the business matters' .Matters for the remuneration committee to consider should include the phasing of any reward scheme s ,the nature of any share option package and the implications of each element of the remuneration package for payments into the director's pension scheme.

Setting an upper limit to options granted as part of a director's remuneration scheme should not be issued at a discount. Before Greenbury, it was quite usual in the UK to grant share options to directors with an exercise price at some discount to the current market price.

Share options should be granted to directors in phased amounts over time the in single large awards.

A firm line should be taken on the payment of compensation to directors dismissed for unsatisfactory performance. In the public perception, a high pay off to an outgoing chief executive can look very much like a reward for failure.

The Board of Ladbrokes Plc hand over the Remuneration Committee with the liability for the strategy in respect of the executive directors and senior executives. In respect of other workers the executive directors have been hand over accountability to run within the remuneration strategy and plan structure recognized by the Board. The Board at the advice of the Nomination Committee makes schedule to the commission, which discuss with the Chairman of the Remuneration Committee. The Committee usually request the Chief Executive and the HR director to be present at committee conference about suggestion describing to the payment of the executive directors, other than when their individual payment is conversed. The Company Secretary takes steps as secretary to the Committee. The Committee and Board think that it is in the security of shareholders to protect some of the betting and gaming industry's most brilliant and profitable persons by given that fully spirited remuneration. The Committee has judgment to think corporate presentation on environmental, social and governance (ESG) matters when putting the remuneration of executive directors. The committee has guarantee that ESG risks are not being lifted by the motivation arrangement for senior management unintentionally interesting careless activities. (http://ar2008.ladbrokesplc.com/remuneration-report )

Disclosure and approval

Greater disclosure about the remuneration of individual director's .The annual report and accounts should disclose for each named director the elements of remuneration, such as salaries and fees, annual and deferred bonuses, compensation for the loss of office, share options and any other long -term incentive scheme. An explanation and Justification should be provided whenever any element of the remuneration other than basic salary is pension able.

A disclosure should be made of nay director with a notice period in excess of twelve months in his her service, contract, together with an explanation of the reasons. The detailed disclosures on the director's remuneration should be checked any external auditors. The chairman of the remuneration committee should attend the annual general meeting, where the shareholders should have an opportunity for a question sand answer session.

The audit committee of Unilever includes a least of three or more non-executive directors; two of them stand forÂ a quorum. The committee assists the boards in satisfying their mistake tasks in respect of the truthfulness of Unilever's financial statements; risk management and internal control activities; conformity with legal and narrow requests; the performance, qualifications and independence of the outside auditors; and the presentation of the internal audit purpose. The committee is also in a straight-line accountable, expose to local rules concerning shareholder endorsement, for the proposal, reward and failure to notice of the external auditors. The revelation committee includes the Group Controller, the Chief Legal Officer, the Group Treasurer and the NV Corporate Legal Counsel. The principle of the committee is to assist the boards make certain that financial and other information that have to be revealed openly by Unilever is revealed in a timely manner and that the information that is revealed is absolute and correct.

(http://www.unilever.com/investorrelations/corp_governance/ )

The remuneration committee report

There should be a report in the annual report and accounts on directors' remuneration policy showing how remuneration compares with other, similar companies. All bonus schemes should depend on satisfactory performance criteria. Long term incentive schemes should be submitted o the shareholders for the approval, in advance of introducing them. The Greenbury report did not give guidelines of deciding what constitutes 'satisfactory performance', and as a result this element of the recommendations has been interpreted widely. For example, there were no guidelines about incentives for longer term performance.

The report should include a statement on the company's policy for granting share options and other long term incentive schemes, together with a justification for any departure from that policy in the policy under the review.

Hampel Report ( Hampel Committee, 1998)

The committee was set up in 1995 to review the progress of the implementation of the findings of the Cadbury and Greenbury Committees.

The Hampel report proposed the consolidation of the Cadbury report, Greenbury report, and Hampel report into one consolidated code. The Hampel report described its task as 'reviewing the substance and implementation of the Cadbury code.

2.2.3 The revised combined code - 2003

The original Combined Code was proposed by Hampel and latter it was revised and brought update by Higgs in 2003.

The key changes made by Higgs are in the changes of the composition of directors. He proposed the increase of non- executive directors and the appointment of a senior independent executive director.

Contents of the revised code

The role and responsibilities of the board, the chairman and the NED's are more clearly defined. The roles of chairman and chief executive should be separate- the chairman should satisfy the criteria for independence on appointment, but should not, thereafter, be considered independent when assessing the balance of board membership.

The chairman is give clear responsibilities, including the introduction of new directors and ensuring the proper flow of information to board members. No individual should be appointed to a second chairmanship of a FTSE 100 company. At least half of the board larger companies, excluding the chairman, should be independent NED's. The criteria for independence are defined.

The board, it committee and directors should be subject to annual performance review. At least one member of the audit committee should have recent and relevant financial experience.

In softening of the line adopted the Higgs Report, it is now acknowledged that:

The chairman nominations committee, expect where the committee is considering the appointment of the chairman's successor. Smaller companies (below the FTSE 350) may find it difficult to meet the provisions relating to board and committee composition therefore, such companies should have at least two independent NED's(rather than a majority) and may have smaller remuneration and audit companies.

Where the companies wish to retain a NED for more than six years, their further appointment will not will not need to be explained in the annual report but such be subject to "particularly rigorous review".

The role of the senior NED should be clarified and the importance of the chairman's role in communicating with shareholders and providing leadership to the NED's emphasized.

The aim of the FRC has been to enhance board effectiveness and improve investor confidence by raising standards of corporate governance. Companies are encouraged to make an early report on the steps, which they are taking to implement the new Code, rather than waiting until their reporting year-end.

In light of these amendments of the Code, companies will need to carry out a comprehensive review of their corporate governance policies and procedures and consider how best to respond. Over the next few months these responses will, no doubt, be the subject of considerable investor, regulatory and media interest.

2.2.4 The revised combined code - 2005

In 2004, the Financial Responsible Council established the Turnbull Review Group that saw the issue of the 'Guidance for Directors on the Combined Code'. The main emphasis of the Turnbull report was to tighten internal control (Turnbull Report, 1999).

Significance of Internal Controls and risk management

The significance of internal controls has been sketched in Turnbull report as follows:

A reliable technique of internal control adds to preservation the shareholders' outlay and the company's resources. A company's scheme of internal control as a crucial responsibility in management of risks that is important to the execution of its business objectives.

Internal control smoothes the progress of the success and competence of operations; assists guarantee the dependability of internal and external exposure and helps fulfilment with laws and regulations.

Efficient monetary monitoring, as well as the preservation of appropriate bookkeeping records, is a significant building block of internal control. They aid certify that the company is not without cause uncovered to preventable financial risks and that financial data employed inside the business and for journal is consistent. They also add to the preservation of property, together with the avoidance and discovery of scam.

A company's objectives, its internal establishment and the background in which it functions are repeatedly developing and, as a result, the jeopardy it tackles is repeatedly altering. A sound system of inner influence consequently depends on a methodical and usual assessment of the nature and amount of the hazard, which the company is uncovered. Since profits are, in part, the recompense for thriving risk-taking in business, the reason of internal control is to assist administer and organize risk suitable rather than to get rid of it.

The risk management system in J Sainsbury plc has been prepared all over the year and up to the date of sanction of the Annual Report and Financial Statements. Recognizing that risk is an intrinsic fraction of doing business, the scheme is intended to recognize major threats and make available declaration that these risks are completely recognized and handled. It is also maintained by a risk policy and rules on how to be relevant the strategy, which are connected all the way through the Company. The success of the procedure is reconsidered two times a year by the Audit Committee, which then reports to the Board. The Functioning Board keep up a risk register, which is frequently re-examined by the Committee and officially, conversed with the Board. The register holds the crucial risks confronting the Company and recognizes the possible influence and probability of the risk at both a gross (pre mitigating controls) and a net (post mitigating controls) stage. Where the net risk needs additional conducts, these are decided with exact timelines. These deeds are narrowly checked until they are completely applied. (http://www.j-sainsbury.co.uk/ )

Objective of the report

To ensure that businesses have sound internal controls embedded in the business processes as the companies pursue their objectives.

To ensure that the internal control remain relevant over time in the continually evolving business environment and to enable each company to apply it in a manner which takes account of its particular circumstances.

The guideline on internal controls requires the directors to exercise judgment in reviewing how the company has implemented the requirements of the Combined Code relating to internal control and reporting to shareholders.

Internal control requirements of the combined code

The principle C2 of the combined code states that ' The board should maintain a sound system of internal control to safeguard shareholders' investment and the company's assets.

The provision C2.1 states 'That directors should, conduct a review of the effectiveness of the group's system of internal control and should report to shareholders that they have done so. This review should cover all material controls, including financial, operational and compliance controls and risk management systems. Turnbull Report, (2004).

The Board of Marks and Spencer have on the whole responsibility for administrating the business efficiently - confirms risks are directed and it's all under inspection. Internal controls and risk management are intended to boundary the possibility of breakdown to attain corporate objectives. Self-governing declaration is offered by the outside auditors and internal audit, who hand over their conclusion frequently to the Audit Committee. They have taken on an incorporated method to risk management, self-governing assertion and internal controls to certify better connection across re-examine and appraisal of risk. They are a wide business with a broad variety of objectives and risks. The Board is accountable for making sure that all goes according to arrangement and that reporting lines and person accountabilities are evidently unspoken. They also have operating strategies and events covering the whole thing from financial planning and reporting, capital expenditure, project governance and information security to business stability, worker performance management and how they do business. (http://annualreport.marksandspencer.com/governance/governance-report )

2.2.5 The revised combined code - 2006

This code supersedes and replaces the Combined Code issued in 2003. It follows a review by the Financial Reporting Council of the implementation of the Code 2005 and subsequent consultation on possible amendments to the Code.

The Financial Services Authority, as the UK Listing Authority, is obliged by statute to carry out a separate consultation before listed companies can be formally required under the Listing Rules to disclose how they have applied this new version of the Combined Code. This consultation is expected to begin September 2006 and, subject to views received, the Listing Rules would be expected to apply to the new version of the Combined Code with effect from some time in the second quarter of 2007.

In the meantime, in view of the limited nature of the changes and strong support that they have received, the FRC would encourage companies and investors to apply the revised Code voluntarily for reporting years beginning on or after 1 November 2006.

The Code holds key and subsequent philosophy and condition. The Listing Rule needs listed companies to create a revelation statement in two parts in relation to the Code. In the primary part of the declaration, the company has to account on how it be relevant the main beliefs in the Code. This should cover both main and supporting values. The form and substance of this division of the statement are not set, the meaning being that companies should have a free hand to describe their authority rules in the light of the ideology, as well as any particular situation be relevant to then which have guided to a specific method. This "comply or explain" method has been in operation for over ten years and the litheness it proposes has been extensively welcomed both by company boards and by shareholders. It is for investors and others to assess the company's statements.

The statement of compliance

A company that has not complied with the provisions of the combined code in full throughout the period must specify the Code provisions, with which it has not complied, for what part of the period non-compliance continued and give reasons for non-compliance. This is a requirement of the Listing Rules of the Stock Exchange. Ignoring the provisions of the code is not an option, but the company has good substantive reasons for deviating the provisions, it is up to the shareholders to decide whether the reason given by the company is valid or not. If the directors an explain convincing the shareholders that the departure from the code provisions is in the best interest of the company, the non-compliance is unlikely to be an issue.

Criticisms of combined code

The Higgs and Smith reports were widely welcomed by different boards like the Financial Reporting Council (FRC) on the revised combined code, but also identified some strong criticisms were merely on the roles and duties of the chairman and the period of tenure for directors.

The board suggested that the combined code needed to put more effort into making the system work, there would be occasions when a company would choose to use the "explain" option, and institutional investors should consider such explanations carefully, giving reasons if they did not accept the explanation.

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